And You Think You've Got Tax Problems

Until the taxman showed up, everything was bubbling along just fine for Coca-Cola Co. About a year ago, the soft-drink giant opened a new bottling plant near Moscow--the first of $100 million in investments planned for the fast-growing Russian market. Coke is racing to grab market share from archrival PepsiCo Inc., which got there first.

Then this spring, Russian authorities without warning scrapped a tax exemption on imported construction materials used at the plant, assessing Coke a cool $1.4 million. In late March, Coke got another surprise tax bill for about the same amount, as the government suddenly hit foreign companies with an "excess wage" tax of up to 38% for virtually all of their Russian employees--retroactive to Jan. 1, 1994. Payment is supposed to be delayed until September, but Coke is taking no chances on penalties. "It's not clear that it has been deferred, so we're paying for all of our employees," says Jack Robinson, Coke's regional legal counsel.

BOUNTY HUNTERS. Most foreign business executives in Russia say they can handle political coups, gyrating ruble rates, and high inflation. But the nation's capricious tax system can do them in. It's not that Russian tax rates are so high--they generally are in line with those throughout Europe. The problem is that many taxes spring out of the blue and carry heavy retroactive penalties--often three times the amount due. Tax cops get extra pay linked to the amount they bring in from penalties. There's little chance for appeal. If foreign companies don't pay, inspectors can freeze their bank accounts, putting them out of business.

Foreign businesses aren't singled out for such cruel tax treatment--the same rules apply to everyone. It's just that many Russian companies find ways around them, from offshore shelters in Switzerland or the Isle of Man to outright bribery of officials. The Finance Ministry estimates that while most former state-owned enterprises pay their taxes, newer businesses renege on up to 70% of what they owe. At least 40% of Russian businesses pay no taxes at all.

The Kremlin is under increasing pressure to collect taxes. The International Monetary Fund insists that the government cut spending and boost revenues as a condition for receiving billions in aid and loans. In a corruption-ridden environment, foreign companies accustomed to playing by the rules are easier targets than local startups.

Angry that Russia is milking U.S. cash cows, the American Chamber of Commerce in Moscow urged Treasury Secretary Robert E. Rubin to bring the tax matter up during the Clinton-Yeltsin summit on May 9-10. Rubin did discuss it with reformist Deputy Prime Minister Anatoli B. Chubais, but he got little more than sympathy.

The irony is that Russia is shooting itself in the foot over taxes. It badly needs foreign investment, but the tax system is driving foreigners away. Take Huntsman Chemical Corp. of Salt Lake City, which in 1989 took a 51% share in a joint venture with Marriott International Inc. and Aeroflot to make plastic cups for the Soviet carrier. Huntsman invested $2 million. In short order, taxes shot up to more than $800,000 a year--when sales were still only $1 million. "There were threats that if you don't pay immediately, we'll shut you down," says Michael C. Eades, vice-president for packaging. Last year, Huntsman bailed out of the venture.

CATCHY TUNE. Russian tax experts agree that they've got a big problem. "We know that because of the instability of taxes, Western firms can't plan their work," says Alexander I. Ivaneev, a tax policy official at the Finance Ministry. The problem is compounded by the Big Six Western accountants in Moscow, which can wreak havoc on foreign companies by giving contradictory advice or interpreting tax rules too liberally.

Still, Ivaneev and other tax officials argue that the four-year-old tax system needs time to mature. The Finance Ministry hopes to present a comprehensive tax code for parliamentary approval later this year. There also are proposals to reward tax inspectors for the revenues they collect rather than the penalties they issue.

But one idea to spiff up the tax system comes straight from a leftover Soviet mind-set. The inspectorate wants to hold a public competition to compose a new anthem: The March of the Tax Police. Hardly a catchy tune for foreigners struggling to do business in Russia.

Before it's here, it's on the Bloomberg Terminal.